Peer to Peer Lending is Evolving

There was a fascinating article today on American Banker that I feel compelled to share with everyone right away. It speaks to a change that is happening in peer to peer lending right now. A change that some may think gets at the very core of what peer to peer lending is all about.

Institution to Peer Lending

I am talking about an evolution away from a pure “peer to peer” space where money changes hands between individual investors and individual borrowers. It is slowly evolving to a space where a mix of individual investors and large institutional investors lend money to individual borrowers. Yes, institutional investors such as pension funds, hedge funds, and asset managers are investing large sums of money now in peer to peer lending.

Here are two quotes from the article that make it clear what the CEOs of Prosper and Lending Club think about this change.

Prosper is being proactive in luring big-money investors to its site, evidenced by its hiring in mid-March of James Alexander, who has 15 years of institutional sales experience…Institutional investors contribute only about 5% of funding volume on the site. Chris Larsen, co-founder and chief executive of Prosper, said he hopes to increase that percentage to as much as 40%.

Lending Club is further along the curve of attracting institutional investors as evidenced by this quote from the article:

About a third of the roughly $16 million of loans funded on Lending Club’s platform this month will come from institutional investors. Laplanche (CEO of Lending Club) said he would be comfortable having as much as half of its funds come from institutional investors.

My Take On Institutional Investing

Whether you like it or not it is clear that in the future institutional investors will play a mach larger role in peer to peer lending. I believe it is a good thing. Actually, I will go further than that. I would say if this wasn’t happening it would be a bad sign for peer to peer lending. You can’t publicize average returns of 10% and not expect the big money players to come to the table.

I also think this is a good thing for smart individual investors. Every one of these institutional investors will have automated plans. It is likely they will have very broad criteria as to which loans they invest in because they will need to put so much money to work. The individual investor who is investing (and reinvesting) smaller sums will be able to have a much tighter investment criteria. And we can also make subjective decisions based on borrower feedback, something that these large investors will not do.

Peer to peer investors who really like the personal aspect of investing in individuals can continue to do so. But they should keep this in mind. Peer to peer lending is first and foremost an investment vehicle (from the investor perspective anyway). Like other investment vehicles it will succeed or fail based on the returns it provides for all investors.

What do you think? Do you like this change? Let me know in the comments.

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Comments

Pros –
1. More borrowers will get their loans funded.
2. Individual investors seeking to liquidate can do so quickly on the trading platform because there is large institutional support there.
3. More money for loans will likely lure more borrowers which will make the industry more self sufficient.
4. Less of a risk that the P2P companies will become insolvent. (Better risk)

Cons
1. Bum rush on borrowers that fit our criteria as “good investments”. (Case in point, Prosper from mid Dec ’10 – mid Feb ’11. Individual investors will be left with the scraps.
2. Depressed interest rates for Investors.
3. Loss of Social Mission in my opinion. The very phrase “peer-to-peer” becomes a misnomer. If money is not primarily transfered person to person than the P2P sites should no longer claim that as their mission.
4. Inevidable relaxed lending requirements. “This will always happen if the supply of money from good borrowers outweighs demand.
5. Institutional takeover of P2P by making it more profitable to invest in “their fund” rather than in individual loans you select yourself.

There is probably more, but I don’t have much time right now to add more. I welcome a small amount of institutional investment, but if hundreds or thousands of pension funds, foriegn investors, hedge funds, bond funds, etc. end up getting into this, then there is no point for an individual investor to get involved anymore. It would make more sense to buy into a P2P investment fund that can get near infinate diversity in their portfolio than to invest in individual loans for a mear $25 a pop. Peter is right. This was bound to happen eventually. I just disagree that an individual investor will end up coming out ahead. Borrowers will REALLY benefit, however.

@Aaron…………..Not to nitpick, but I’d disagree with your “Pros” #2 item. I don’t think it’ll add anything to the liquidity for individual investors UNLESS the individual investors are offering notes of a few hundred dollars each. I can’t imagine a scenario where institutional investors would have anything to do with $25-$75 notes. The rest of your points seem pretty solid at first glance though I’d probably consider the loss of p2p to be a pro rather than a con.

My preliminary thoughts ……..I think we first need to define what we mean by “institutional investor”. I can see the teachers pension fund in Montana perhaps being an investor…………..but can’t see the sovereign wealth fund of Kuwait having any patience with this nickel & dime scenario. Yet they’re both called institutional investors. So which one are we talking about?…… Even it it were $100 million a month being lent out, it’d be a tiny drop in the bucket of consumer lending. Do institutional investors not have another way of playing in the consumer lending sandbox?

Would “institutional investors” tolerate having their money sit around earning zero interest for weeks on end without getting fully funded? Would they believe/tolerate some of the BS numbers that are casually tossed around by the p2p companies? Would they feel that the liquidity is adequate? In this interest rate environment perhaps, but what about in a more normal interest rate environment?

Overall though I’d have to say that it’d be a positive thing. We as individual investors have little if any financial & political muscle. Institutional investors big or small do. Hopefully their presence will cause the companies to be more “factual” with their facts.

@Dan, In defense of #2, I often see reflective-rupee, Artisan_Blue, Seeksvalue, etc. on the trading platform of prosper. They seem to be indiscriminately bidding the full value of just about every note that shows up on the platform. The only way to outbid them is to try to buy the note at a premium. I put up 12 notes (I needed some cash to pay my wife’s taxes) from $25-50. Reflective_rupee initially bid on all of them. The value increased a bit as more investors got in later, but this institution got pretty much all of em except the 5 that were sold at a premium.

I can only assume that this is the same at LC, but this is hard to check because accounts are numbered and not named like it is on Prosper.

@Dan, I am looking at the size of their portfolio and attributing that to an institutional investor. You can actually look this up on the erics credit community website. Reflective-Rupee has the largest portfolio with over $1,000,000 invested in NEW loans. The site does not keep track of the trading on the Folio site, so it is likely much higher than that. Even if these are not institutional investors, I think I can reasonably assume that they will act in a similar fashion.

@Dan/@Aaron, Interesting discussion here. First, I think by institutional investors we mean some kind of fund (be it a pension, hedge, or some kind of investment entity) not an individual. High net worth individuals may have $1 million or more invested but as Dan pointed out they will have less political clout than an institutional investor even if they behave in a similar fashion to institutional investors.

@Aaron, I have no idea whether Reflective Rupee, Aberdeen or some of the other big investors on Prosper are individuals or not but I do know this. It is not difficult to write a program to automate investing on the trading platform. I have swapped emails with this guy who has a program he runs looking for notes on the trading platform that meet his criteria. These institutional guys are most likely using automated systems like this one. I imagine the guys you mention on Prosper are taking advantage of this.

@Dan, And yes peer to peer lending is not going to be getting large investors who only like to put tens of millions of dollars to work. But there are obviously plenty of smaller players who are happy to work in the six or low seven figure range. And as you point out I think these guys will be unwilling to accept any false marketing claims because you can be dead certain they are going to know their exact real return on their money.

Finally, the article on American Banker mentioned that Lending Club is downplaying the “peer to peer” name, you won’t see it mentioned on their home page at all. Same with Prosper for that matter. I don’t think that is a bad thing. But then what will we call it?

@Peter……….I’d have to agree with your assessments on this one. I’d say the more institutional investors the better. I wouldn’t be surprised if LC did get up to 50% institutional investors in short order. On the other hand I’d be shocked if Prosper increased theirs dramatically. I’ve been a small investor there for only 2 months & I already have a page long list of complaints that I’ll not bore you with here. They need to seriously tighten their operation.

@Aaron………..If I were a betting man, & I am, I’d bet that the names you mentioned are individuals. To me they act & sound like individuals despite their high dollar value accounts. Of course what do I know?

Interesting article as always, Peter. I think one positive that may outweigh some of the negatives will be a demand by the institutional investors for more information in the listings and on Folio. Perhaps credit reports updated every 6 months/1 year after the loan is issued. (Did the borrower actually pay off that CC debt or go on another spree?) Statements of net worth or at least something verifiable regarding the borrowers equity in their home. Also would like to see more info regarding collections actions on the loan performance page instead of “Borrower contacted Lending Club”. (Well…What did the borrower say??)

Also another positive is that this may bring us one step closer to secured loans & home loans.

@Bruce, This is one of the key areas where I think there is huge room for improvement. Once a loan is funded, apart from a credit score, we get very little information about the changing circumstances of the borrower. I fully expect this will change at some point.

Secured loans of all kinds are also in the future, there are already limited trials of companies doing both residential and commercial rest estate loans.

@Dan, Prosper will probably have a tougher time getting institutional investors but if they can show steady growth for the next few months and get over $10 million in monthly loans before the end of the year I could see renewed confidence by the bigger players. But as you point out they need to improve many things before they will attract as many big players as Lending Club.

@Bruce/Peter…….Considering the number of notes that we’re dealing with would you actually continue looking at a note periodically after you’ve bought it?
As for myself, the only time I look at a note after purchase is if it starts displaying signs of trouble………….like potentially going into grace period or a payment plan scenario. Other than that I know I won’t be looking at credit histories. Do you guys feel differently?

@Dan, What I would like is some kind of monitoring service. So an investor could be notified if something changed on their credit report. Right now, the only way to find out if the credit score has gone down is to view each note individually. This is not realistic for several hundred notes. Of course, the downside of any alert system is that it would be available to those people on the trading platform, so it might not end up being that effective anyway.

So what do you mean by “displaying signs of trouble” – I presume that is just a drop in credit score, right?

I am thinking that this will limit the amount of loans that small investors (peer) can scan and filter because some big computer based filtering program will dynamically grab them up. Even now, on LC, I can run my filters and find say 3 loans today for about 10K each, only 3% filled — then 2 hours later – 1 is gone (this happened today). I think the peer will become P2I now, and the P2P will be gone.

@Peter………….No, it means exactly like I said…………. potentially going into grace period. The credit score has nothing to do with how I determine if that’s going to happen or not. Credit score movement is just something I glance at to give me an idea on pricing the note for quick sale, though the sale price variance between a dropping score or a rising one on notes displaying signs of trouble is surprisingly small.

How I determine if a note is displaying signs of trouble before it actually gets into trouble is something I will happily share with anyone who will buy me an Audi R8. No, not the one made by Mattel Matchbox, a real one………..though I am flexible on the color. 🙂

@Les, I think you will find that the fast funding of notes is a function of the time of month. The last two days of the month is when most of the institutional money comes in and fund notes. Right now, you will notice there are 458 notes available on LC. By Friday morning, I predict that number will be around 250. Millions of dollars comes into LC in the last two days of the month. I try and invest outside this time so as to avoid the institutional rush.

@Dan, Well you really have me intrigued now. I will happily buy you an Audi R8 (your choice of color) when the annual revenue of the Social Lending Network surpasses $10 million…..

@Peter…………..That sounds great, I’ll get that info to you when the revenue surpasses $10 million. 🙂 I’m a little concerned though with the time frame & whether I’ll be even able to walk by the time that happens……………..to say nothing of drive.

@Peter/others………..Well I’d like to think that all our complaining has had some effect as Lending Club has created a position of “Director of Information” that will be directly responsible with revising & better communicating the whole NAR thing, overall returns, default rates etc. & with communicating that info to us lenders more effectively ……………..& hopefully more accurately as well. The guy they hired is Mohammed Saeed al-Sahaf & he has a serious no BS background. Do a google search & you’d be impressed, I think.

[…] Peter Renton of the influential “Social Lending Network” site suggests that an “evolution” is underway from the initial “peer to peer” business model, where money primarily changed hands between individual investors and individual borrowers, to a new model that must cater to the participation of large sophisticated institutional investors, such as pension funds, hedge funds, asset managers (see “Peer to Peer Lending is Evolving”). […]

[…] Peter Renton of the influential “Social Lending Network” site suggests that an “evolution” is underway from the initial “peer to peer” business model, where money primarily changed hands between individual investors and individual borrowers, to a new model that must cater to the participation of large sophisticated institutional investors, such as pension funds, hedge funds, asset managers (see “Peer to Peer Lending is Evolving”). […]

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